Manufacturing capital through a property development project is a great way to boost your investment portfolio’s profitability.
However if not managed appropriately from start to finish, you run the very real risk of over-capitalising and realising a loss instead of that much anticipated gain.
As a property investor, why would you waste valuable time and money on a project that might belly flop due to poorly managed timeframes and budget blowouts?
It does happen though, with problems often arising as a result of poor financial planning. Here are 6 financial considerations you’ll need to work through in order to give your development a firm footing.
1. Your borrowing options.
Borrowing to undertake a development is a very different proposition to applying for a relatively straightforward mortgage. For a start you represent a higher security risk, so lenders will be a lot stricter when it comes to their criteria.
Not only will they carefully assess the viability of your proposed project, they’ll also consider your experience and that of the team you put together to see the construction process through.
It’s likely your choices around the types of loans and associated facilities you can access, as well as the lender, will be somewhat restricted.
For instance, depending on how many units you intend to build lenders will consider your project to be ‘residential’ or ‘commercial residential’. If they decide on the latter, your mortgage options are immediately diminished.
You’ll also need more upfront funding of your own if it’s a larger scale development of say, four plus units. Typically, you can obtain 80 per cent of the final project cost from the banks (not its end value) if you plan on building 2 dwellings on site.
Whereas 3 or more units would require a lower LVR of around 70 per cent and the lender will ask you to chip in with a greater amount of existing equity and/or presales.
2. Your application.
Your submission must be professional and demonstrate appropriate due diligence that accounts for all identified contingencies.
Present your application as you would a business plan and include as much relevant detail as possible, including:
- the scope of works and anticipated timelines
- the amount of money required and how much you’re contributing
- cost projections and a concise budget for the build from start to finish
- risk assessment and explanations of how you’ll mitigate identified risks
- qualifications and expertise of the project manager and major contractors involved
- feasibility study
- projected sales figures and net gains
- site description, floorplans, architectural designs and zoning
3. Effective budgeting and cost management.
Budgeting and management of project funds is essential to your success. The banks will baulk if you don’t appear to have all your fiscal ducks in a row. And your lender certainly won’t be pleased if you approach them half way through the build to ask for more capital due to poor planning.
Account for every potential cost, including fixtures and fittings, as well as timing of things like pre-sales in your budget forecasts. Get all build quotes in writing to avoid conflicts with suppliers down the track.
You should also include a generous contingency, of at least 5 per cent of the estimated funds required.
Remember, your bank won’t hand over the entire capital at time of loan approval, but will meter it out in instalments as follows:
- deposit
- base stage
- frame stage
- lock up stage
- fixing stage
- completion balance
Careful number crunching reduces your risk of coming up short at some point throughout the project, and ending up with unpaid contractors walking off the job.
4. Keep it real to avoid over-capitalising
The majority of property developers fail because they get carried away with design aspects and/or mismanage the project budget from the outset.
Some get caught up in the creative process and before you know it, are building palatial townhouses with executive fit-outs in an area where the predominant market happens to be young families rather than high paid executives.
A property development is a massive undertaking and as such, the end figures MUST stack up before you turn that first sod. Aim to achieve a profit margin somewhere around 20 per cent gross (at the very least).
And keep these figures in mind when working out…
5. The project’s feasibility
It’s essential to conduct a thorough feasibility study on any potential development, beginning with a critical assessment of the location and site you’re considering.
- How much does the site cost?
- What is the zoning?
- How cooperative is the local planning authority?
- Will demolition of any existing dwelling(s) be required?
- What does the local property market look like?
- Who are the predominant owner-occupier and tenant demographic in the area?
- Will you on-sell all product or retain for tenancy purposes in your portfolio?
- What projected capital growth and/or yields can be achieved if you hang onto the completed properties long term?
Answering these questions will give you a much clearer idea as to whether the project will be worth tackling in the long run. Remember, this is about big picture stuff as well as the smaller details.
6. Timing
There are so many steps to take and boxes to tick when it comes to a property development project.
Staying on top of it all can be challenging for the novice, so it’s advisable that you contract an appropriately qualified and experienced project manager to coordinate the build from start to finish.
The process should look something like this…
- Before you even look at land, work out your finances and engage a mortgage broker, real estate agent (to consult about the local market), solicitor, architect and development manager.
- Speak with the local council and from there, come up with a concept.
- Secure your land at a commercially viable price to ensure the project will be profitable.
- Apply for development approval – this process can take many months of to-ing and fro-ing with the local planning department, so account for this in working out your project timings.
- Have working drawings prepared to obtain a building permit.
- Get some quotes from local builders and trades and finalise construction finance.
- Construction phase starts and generally lasts anywhere from 6 to 12 months, depending on the project scale and how well it’s managed.
- Employ your exit strategy (which will have been devised well before you started!).
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).